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GUEST OBSERVATION
Finally, <a href="https://fsi.gov.au/publications/final-report/executive-summary/" target="_blank">Financial System Inquiry</a> chairman, David Murray, has brought some consistency into two hot debates running in finance.
Parliament, financial media commentators and a whole range of vested interests have argued at length over the last year about who can give financial advice, how they should be remunerated, how they should be trained and what qualifications they should have.
At the same time there has been an <a href="/news">ongoing debate</a> in the media, through speeches and submissions, about who is appropriately qualified to be trustees of large superannuation funds.
The same groups have made the opposite arguments in the two cases.
One group of institutions, mainly the industry super funds, has been arguing that we need to have greater independence of financial planners and advisers. Another group of institutions, mainly the retail super funds, have been arguing that advisers can be aligned but should be more closely controlled. Most importantly, they argue that they should be more professional. The recent political fight around the roll back of Labor’s Future of Financial Advice (FOFA) reforms has essentially been focused on these issues of independence and professionalism.
At the same time the retail super funds have been pushing to ensure that a majority of the directors of superannuation funds should be independent. They are pushing the case for greater professionalism of superannuation trustees. By contrast the industry super funds have been arguing that this is not necessary, and that trustees do not need special knowledge. Most particularly they have argued that trustees coming from particular employers and particular employee groups, without any particular qualification, are appropriate.
Murray has pointed out the inconsistency. If the person advising me on my $200,000 superannuation fund must be professional, then the trustee for a fund managing $2 billion for its members surely deserves the same respect.
Clearly both are important. An adviser who gives me bad advice can ruin my retirement and my life. Notably however, a superannuation fund which makes mistakes can cost thousands of people security in their retirement. There are three reasons to think that the latter is more important.
The 2010 <a href="https://www.supersystemreview.gov.au/content/content.aspx?doc=html/final_report.htm" target="_blank">Cooper report</a> into the superannuation system pointed out that by 2035 the average superannuation fund supervised by the Australian Prudential Regulation Authority (APRA) (that is, excluding the self-managed sector) will be managing $53 billion on behalf of superannuants. This is a very large amount of money, the lifetime savings of thousands of members. Putting to one side the politics and the vested interests, clearly it is extremely important that the directors of superannuation funds be appropriately qualified and highly skilled.
The second reason is that superannuation sector is not simply important to individuals, but to Australia’s economic future. Murray makes clear that the superannuation sector is well on the way to being one of the largest components of the Australian financial system, not far from the size of the banks. Where and how it invests will shape much of Australia’s growth and development. This alone is a key reason to demand a high degree of professionalism in the management of the sector.
The third argument Murray makes for independence of directors, is that since people can choose which fund they join, the superannuation funds will be increasingly de-linked from particular industries. If anyone can join a fund, there is little reason for the trustees of the fund to belong to a particular sector of the workforce (employers or employees).
One would actually hope that APRA would have a say in approving who could be a trustee of a major superannuation fund, and would set very high standards of training and experience.
There are lots of vested interests involved in these debates. Murray has however given us reasons to sit back and ask, what is the best structure for the future? This is important to Australia’s future.
So let’s have some honesty and consistency in the public debate. If professionalism is important at the level of the individual then we should expect high standards of professionalism from the trustees of superannuation funds. Arguably, trustees of major funds should be held to a higher standard.
Rodney Maddock is Vice Chancellor's fellow at Victoria University and adjunct professor of Economics at Monash University.
This article was originally published on <a href="https://theconversation.com" style="line-height: 1.3em;">The Conversation</a>.
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rmaddock-AxiRakmDz9

Murray pinpoints inconsistency on financial advice and super trustees

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GUEST OBSERVATION
Over 40% of mortgages in Australia are sold by mortgage brokers, not by their manufacturers - an issue that has the CEO of Australia’s fifth largest bank, Suncorp, <a href="https://www.theaustralian.com.au/business/suncorp-chief-patrick-snowball-lashes-dominance-of-big-four-banks/story-e6frg8zx-1226881287464" target="_blank">arguing</a> the sector is skewed towards the big four banks.
There are two distinct components of the mortgage market: a retail market with a wide variety of sellers, and a wholesale market.
<img src="https://62e528761d0685343e1c-f3d1b99a743ffa4142d9d7f1978d9686.ssl.cf2.rackcdn.com/files/46335/width668/jm9wyrsb-1397454304.jpg" alt="">
Value of housing loans advanced by lender. Australian Securitisation Forum
The four big manufacturers of mortgages in Australia are the big four banks. One of the key issues for the <a href="https://fsi.gov.au/" target="_blank">Murray inquiry</a> into the financial system will relate to competition, or the lack thereof, in the manufacturing of mortgages. Does it matter that some 90% of mortgages are manufactured by four producers?
There are a number of ways of answering this.
Oligopolies reign…
The first is that there are many industries in Australia with fewer than four major manufacturers of goods and services. Telephone services, domestic airlines, energy supplies, postal services, cars, steel etc. all come quickly to mind. In fact, most Australian industries are characterised by a small number of manufacturers. Any industry with economies of scale, like banking, seems likely to be relatively concentrated given the size of the local market.
The second is to ask whether the concentration is temporary or entrenched.
There were a lot more manufacturers of mortgages before the financial crisis. Most of them were funded not from deposits but by securitising their mortgages and obtaining funding from the wholesale markets. During the crisis this market contracted sharply, mainly because of problems in the US market for securitised product, which made the business model unviable. The government stepped in under Treasurer Swan and subsidised securitisation by the smaller banks during the crisis to enable them to stay in the business. This was a subsidy from taxpayers directed exclusively towards the smaller banks.
As the securitisation market returns, as it should because there were no problems with the market in Australia, then this will return to be a secure funding source for the smaller banks. The rebuilding of market sentiment will allow the smaller banks to re-enter the market as manufacturers of mortgages.
<img src="https://62e528761d0685343e1c-f3d1b99a743ffa4142d9d7f1978d9686.ssl.cf2.rackcdn.com/files/46337/width668/qx6vgx59-1397454478.jpg" alt="">
Residential Mortgage Backed Securities by issuer type. Australian Securitisation Forum
Macquarie Bank too has shown a willingness to depart from the mortgage market when times are difficult but to re-enter aggressively as it has recently. Again this is another indicator that the market concentration is high but the market remains contestable.
Price competition
The third broad concern is whether there is price competition for mortgages at the wholesale level. At the broadest level the Reserve Bank has concluded:
"The available evidence suggests that the average spread to the policy rate on variable-rate mortgages in Australia is within the range of those in other advanced economies" - RBA submission to the Murray inquiry.
So the overall level of mortgage margins does not appear to be out of line with prices in other countries.
The remaining issue is whether there is price competition between the four manufacturers, and whether market share changes when price changes. The normal test used in industrial economics is to ask whether an incumbent would lose significant market share if it raised prices by 10% above the level of its competitors.
With mortgage rates currently around 6%, the question is whether a bank would lose significant market share if it offered a standard variable rate of 6.6%, while the other manufacturers had prices around 6%. There really seems little doubt that the high price would cost an incumbent significant market share, suggesting that no provider really has market power in mortgages. Just by cutting its mortgage list price by 0.10 to 0.15 of 1%, NAB increased its market share significantly during its break-up marketing campaign.
Since the financial crisis the big four banks have become the principal manufacturers of mortgages in Australia. They market some mortgages directly, some through second tier brands, and some through brokers. Their leading position in manufacturing since the crisis is mainly the result of the wind back of second tier banks which were funded through securitisation in the wholesale market, and partly because of the changed status of St George and Bankwest when they were taken over by majors.
Such a high level of concentration is not unusual for an Australian industry. Nor is it clear that prices are out of line. The situation is also likely to prove temporary as re-emergence of the securitisation market will enable alternative manufacturers to fund their lending, and new vigorous competitors like Macquarie have already re-entered the market.
Rodney Maddock is Vice Chancellor's fellow at Victoria University and adjunct professor of economics at Monash University.<img src="https://counter.theconversation.edu.au/content/25587/count.gif" alt="The Conversation" width="1" height="1" style="line-height: 1.3em;">
Rodney consults to a range of financial sector institutions. Some of his current research on financial regulation is funded by the Centre for International Financial Regulation. 
This article was originally published on <a href="https://theconversation.com" target="_blank">The Conversation</a>.
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Looking for a home loan? Choose from one of these four options…

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Australian banks are much more heavily exposed to mortgage lending than banks in most parts of the world, which is why the latest publication of <a target="_blank" href="https://www.apra.gov.au/statistics/Pages/default.aspx">APRA data</a> on home lending has set the hares running.
The data showed 14% of the recent mortgage lending by banks has been for loans which exceed 90% of the relevant property valuation.
The IMF has also been in Australia on its annual review and <a target="_blank" href="https://www.propertyobserver.com.au/https://www.abc.net.au/news/2013-11-21/imf-issues-property-warning/5107090">commented</a> on the risk to the banking sector from its exposure to mortgages. It often does.
This is a well-worn theme. The IMF’s last <a target="_blank" href="https://www.imf.org/external/pubs/ft/scr/2012/cr12305.pdf">review</a> (p7) expressed the risk in these terms:
“Domestically, despite a recovery in the household savings rate and a recent softening of house prices, high household debt coupled with elevated house prices remains a vulnerability”.
It is an important issue, particularly in Australia. Kevin Davis has <a target="_blank" href="https://www.rba.gov.au/publications/confs/2011/pdf/davis.pdf">pointed out</a> the unusually high levels of exposure of Australian banks to residential real estate. He suggested that some 59% of the total loans of Australian banks in 2009 were for this purpose compared with the US 38%, Canada 32%, Germany 17% and the UK 15%.
In essence there are two areas of major risk in the Australian financial system.
Australian banks are heavily exposed to domestic mortgages and they are still very reliant on borrowing from foreign wholesale markets to fund their lending.
The banks have worked hard to manage the funding risk in recent years by increasing their use of local deposits and to ensure that their offshore borrowing is more long term and hence more stable. We can worry less on that score than we did once.
Bank lending for mortgages also looks quite stable. Most borrowers have a lot of equity in their houses so that even a big price fall would not mean their loans were worth more than their houses, and most have made extra payments so they have a buffer against unemployment.
Less than 2% of loans are low-doc, potentially the highest risk category. The local banks also normally require borrowers take out insurance when they are borrowing more than 90% of the value of the loan.
We can see the impact of these factors in NAB’s recent results. The bank’s average mortgage borrower is eight months ahead of the required payments, and two-thirds of customers are at least one month ahead, the average loan to valuation ratio on its books is 48%, and some 15% of the book is insured. The consequence is that the bank’s loss rate on mortgage lending is 0.04%. Clearly there are still risks, for example if a mortgage insurer were to collapse, but it looks quite safe.
Nevertheless most analysts, investors and parties which lend wholesale funds to the Australian banks, pay close attention to their housing exposures.
Particularly in an environment where credit growth is quite slow, one way in which banks can increase their returns is to take on more risk. Hence the interest in the APRA data published this week. Are the banks moving up the risk curve?
Even there it is not clear that there are particular concerns (see chart below). The recent proportion of loans at high LVRs shows no clear trend over the last two years. Looking back earlier we see similar numbers for the period in the mid-2000s.<img width="470" style="font-size: 0.8em;" src="https://c479107.ssl.cf2.rackcdn.com/files/36781/width668/sb5j4qpk-1386046684.jpg">
Percentage of loans above 90% of property valuation (High LVRs). Source: APRA
Just eyeballing the data suggests that APRA might well have had some conversations with the banks requesting them to keep the proportion of high LVR loans in their portfolios to below 15%.
 
<hr>
 Rodney Maddock is Vice Chancellor's fellow at <a target="_blank" href="https://www.vu.edu.au">Victoria University</a> and adjunct professor of economics at <a href="https://www.monash.edu.au" target="_blank" rel="nofollow">Monash University</a>.
This article was originally published at <a href="https://theconversation.com">The Conversation</a>. Read the <a href="https://theconversation.com/risk-on-australian-banks-skirt-unofficial-home-lending-limits-20839">original article</a>. 
 
<img width="1" src="https://counter.theconversation.edu.au/content/20839/count.gif" height="1" alt="The Conversation">
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Over-exposed? Australian banks are taking risks by skirting unoffical home lending limits

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China has signalled its intention, reiterated in the recent Third Plenum, to open up its financial markets. This would be an important reform which carries significant risks and opportunities both for China, and many opportunities for Australia.
There are two main elements to the reforms. The first is to remove many of the regulated prices in the domestic financial system and to allow markets more scope to set them. The second is to float the Renminbi and allow freer international flows of capital. Both carry substantial risks.
Until recently bank lending and deposit rates, and hence bank net interest margins, were heavily regulated. The effect was to guarantee bank margins and protect the (mainly government owned) banks from much of the low quality lending they had engaged in during the 1990s.
With the deposit rate set artificially low, funds were cheap. Over time however less-regulated financial institutions found ways to offer higher returns to depositors. Many of these wealth management products were effectively deposits in that they could be readily turned back into cash. China has thus seen a rapid growth in its shadow banking system as a result.
The deregulation of lending rates squeezed the banks. Since they were forced to pay a below-market price for deposits but had to compete in lending, their margins have been under pressure.
Deregulating deposit rates is the next big step. But regulators are worried about whether the banks will cope with competition for deposits. The risk of bank failure increases significantly.
China currently limits its banks to only lend out a fixed proportion of their deposits, that is the volume of their deposits always exceeds the value of loans they make – unless they make very poor lending decisions. The deregulation of deposit rates puts this at risk. It is now far more likely that banks will fail, and depositors lose money. Since China does not have a deposit insurance system, this is a significant risk.
Protecting depositors
China is currently working on developing the required deposit insurance scheme. We are unlikely to see the deregulation of deposits until that is in place. Even that though does not end the problems.
The transition of banks from only having to worry about the quality of their assets (loans extended) to also having to worry about their liabilities (deposits and other forms of funding) is problematic.
Australia <a href="https://penguinunearthed.wordpress.com/2006/04/02/book-review-westpac-the-bank-that-broke-the-bank/" target="_parent">almost lost</a> one of our major banks (Westpac) in the process of adjusting to a liberalised financial system, although there is little doubt that the economy functions better now than it did in the 1980s.
The implicit trade-off between the additional growth generated by a better allocation of resources valued against the risk of more frequent crises has generally come down in favour of liberalisation (see for example Ranciere, Tornelland and Westerman’ paper “Systemic Crises and Growth” in the Quarterly Journal of Economics, February 2008).
Those with longer memories will also remember many Australians losing money when they took out loans in foreign currencies just before a big fall in the Australian dollar. Some elements of the Asian crisis were also worsened by foreign currency borrowing as countries (partially) liberalised their capital accounts.
Both the internal reforms and the floating of the currency provide opportunities. While Australian banks, wealth managers and insurers have struggled to get a strong foothold in China in the face of strict regulation, that should change with the next phase of reform.
The biggest opportunities for Australia however will derive from the opening up of the Chinese capital market to the freer flow of money in and out of the country. Recent <a href="https://www.imf.org/external/pubs/ft/wp/2013/wp13189.pdf" target="_blank">work by the IMF</a> suggests while it’s hard to see whether China will finish up importing or exporting capital, the size of the flows both inward and outward will increase significantly. Chinese will seek to diversify their portfolios away from China, and foreigners will try to increase their exposure to China.
The IMF paper actually suggests that Chinese will increase their current foreign asset holdings by a factor of five, and that foreign holdings of Chinese assets will increase by a factor of three. That is, China will be a net foreign investor.
Australia will have to get used to the idea of Chinese companies and individuals continuing to buy local assets. This should bid up the price of assets, which is good for their owners, but is likely to raise community concern. There will obviously be sizeable business opportunities involved in servicing this outflow.
The other flow is also important. Australian wealth managers, and Australian companies, will have very significant business opportunities servicing the outward flow.
 
<hr>
 Rodney Maddock is Vice Chancellor's fellow at Victoria University and adjunct professor of economics at <a href="https://theconversation.com/institutions/monash-university" target="_blank">Monash University</a>
 
This article was originally published at <a href="https://theconversation.com">The Conversation</a>. Read the <a href="https://theconversation.com/china-is-liberalising-its-banks-and-thats-good-news-for-australia-20708">original article</a>.
<img width="1" src="https://counter.theconversation.edu.au/content/20708/count.gif" height="1" alt="The Conversation">
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